Healthcare Advisor: Is Your Compensation Formula Working?

Whether you are an independent physician practice, a hospital employing physicians or an advisor to physician practices, as either an attorney or accountant, the compensation formula is a central focus for financial and operational effectiveness of a physician practice. If it is working, the environment is collegial for the physicians and employees; but when it doesn’t work, then the problems can seem unsurmountable and the effectiveness of the practice can diminish.

What are the warning signs that a formula is out of step with the practice profitability or group expectations?

  • Delays in the distribution of physician compensation until sufficient cash is available
  • Borrowing to pay quarterly or year-end bonuses
  • Knowledge of the calculation is limited to the practice administrator, the practice’s CPA, one or two physicians or some combination. In many cases the calculation is fine, but when key people leave the practice, the history can leave as well.
  • Misunderstandings among physician owners as to process, calculations or inputs
  • Disputes in the allocation of cost and equality of the formula
  • Lack of confidence in underlying data
  • Difficulty or errors in calculating physician work relative value units (wRVUs)

A formula can take on various forms. It could be as simple as time worked. It could be productivity based. Or the calculation could include allocation of revenues and expenses. This article focuses on some of the common errors made in compensation formulas particularly with a net cash available focus. We review primary control tests to identify or avoid errors, and we review issues in compensation formulas involving productivity measures such as wRVUs.

First, here are some basic principles when designing or redesigning practice-based compensation formulas:

  • If the mechanics of preparing the compensation formula are flawed, then the agreed formula, no matter how good, is useless.
  • Balance to cash. Virtually all practices are on a cash basis and can only pay out what is collected and left after other expenses. A monthly calculation should always account for the actual cash adjusted for pending expenses.
  • Calculate a rolling compensation. Many practices calculate a monthly compensation related to collections and expenses, but expenses in a practice may straddle months. For example, one month has two months’ worth of invoices, three staff payrolls and includes one time or sporadic expenses. By calculating each compensation adjustment on a cumulative basis during the year, you eliminate most of the problems that arise from payment of expenses not matching revenue or swings in receipts that can occur when a physician has been on vacation.
  • Keep it simple. You want to pay physicians relative to their peers in the practice, but we see formulas with too many calculations and too many manual adjustments to track down. The more calculations and exceptions the greater the chance for error. The biggest test for what to do and what not to do, is to ask, “Does it really make a difference?”
  • Compliance is a must. By now, most physicians are at least familiar and understand that ancillary testing or therapeutics cannot be directly attributed to the ordering physician unless he or she is directly involved. The simplest approach used by many practices is simply to allocate ancillary revenue and expense separately and in equal pieces. There are alternatives, including the ability to group at least five physicians into individual pods for the purpose of dividing ancillary revenue. A practice or hospital should consult with legal and health care advisors experienced with Stark Law before adopting a methodology. If a methodology other than dividing equally is being considered, understand the resulting difference(s) in physician compensation, if any, prior to adopting.
  • Review productivity calculations. Review these calculations periodically to ensure that information used to determine productivity is current and calculated correctly. For example, does the determination of wRVUs account for all adjustments related to secondary procedures?

The points above are easily acknowledged, and many would believe they are following these fundamentals, but the real challenge is in the execution. Does the formula really work? We have seen a number of formulas that follow the basic concepts that fail to produce the proper results or run the risk of producing erroneous distributions. There are some key control points that improve the accuracy of compensation formulas. One or more of the following would have prevented the problems described in the examples to follow.

1. Balance the compensation formula to the cash available.

2. Calculate compensation on a year-to-date basis over the course of the year, whether monthly, quarterly, semi-annually or annually.

3. Distribute compensation and bonuses uniformly at the same time. If the practice calculates bonuses on less than a quarterly basis, allow a payment less than the expected amount, say 80 percent. Calculated deficits should be recuperated by decreases in the monthly allocation or in the next bonus period. This way, if the practice has a hiccup in its finances, everyone is equally at risk and repayments by individual physicians are minimized if not eliminated.

Below is a sample of issues we have faced. In each case the physician group did not suspect there was a problem.

1. Over time a formula was updated. Along the way a line was added into Excel or the treatment of an expense or revenue changed, and the formula generated a distribution to the physicians which no longer balanced to the cash in the practice.

a. Some little problems can add up.

i. An expense is pulled out to be charged directly to the individual expenses. Somewhere along the line, the cell(s) holding the expenses change. While the item appears in the spreadsheet, the expense is no longer part of the total expenses being subtracted resulting in an overstatement of compensation.

ii. In preparing the calculation, one or more expense accounts are not assigned to direct or overhead categories and income is overstated, or an expense account is counted in two separate groupings of expenses and income is understated.

iii. A unique payment, medical director, call pay or other is to be credited to a physician and the item is added to revenue. However, unknown to the preparer, the unique payment has been included with other cash receipts from patient and insurance payments, resulting in a double counting or overpayment.

b. These items would have been caught by:

i. Balancing to cash.

ii. Periodically testing the spreadsheet or having your accountant test it anytime there is a change to the math.

2. When pulling data from your QuickBooks file or other accounting software understand, the classification of expenses and how any subsequent postings might impact the current month.

a. One practice doing a standalone monthly calculation always pulled the financials at the end of the first business day of the next month. Collections staff and accounts payable clerk would continue to post both receipts and payments to the previous month, thinking they were doing it right. As a result the receipts and payments posted in the prior month were never picked up.

b. This problem would have been caught by:

i. Balancing to cash.

ii. Using a rolling compensation calculation. (Be careful at year-end.)

3. Under pressure for higher physician income, the practice manager making the calculation stopped paying some bills including payroll taxes to increase or maintain distributions to the physicians. Management/physicians should review unpaid bills related to the calculation.

4. A practice administrator of more than 20 years for a successful specialty practice retired. No one else in the practice, including physicians or accountants, was familiar with the calculations that were still being made manually. Fortunately, the retiring administrator was honest and bonuses were distributed only semi-annually, allowing time to replicate and streamline the calculation.

5. How are credit balances treated?

a. Credit balances have to be remitted to the patient or payer timely. If not remitted timely, the amounts due are included as receipts to the practice. This amount can become substantive over a short period of time and distort practice income. In addition, this can have a material impact on part-time or low volume physicians.

b. Compensation can be overstated if:

i. Refunds are not part of the formula or are not allocated to the physician who received the initial payment.

ii. The practice does not timely address credit balances, a violation of Medicare and Medicaid, most managed care contracts and state laws on unclaimed property.

c. To avoid this mistake:

i. Balance to cash.

ii. Review the credit balances timely.

6. One practice borrowed money each year to fund physician salaries at the prior year’s amount. The practice had drawn the maximum approved for the line of credit. Over time it was not only the debt that was problematic, but as a Professional Corporation, the group had tax losses that could not be passed through to the physician owners.

7. Assign special payments or receipts. Any time a physician is credited with a special payment (e.g. Medical Director, call pay) or charged with a direct expense, make certain the revenue or expense is actually reflected in the calculation only once.

Other Issues to Consider in a Formula:

1. How are expenses divided?

a. Direct expenses of the physician are recorded and charged appropriately to the physician.

b. Variable costs of the practice, such as supplies, drugs, billing costs and certain staffing, can be allocated by receipts or other measure of volume.

c. Fixed costs – It costs everyone something for just showing up. Rent is typically fixed without regard to patient volumes. Similarly, practice management, reception and other salaries are a cost of doing business. These are best divided equally.

d. Ancillary expenses – If ancillary revenue is to be divided separately with Stark, it is best to match as much of the associated expense to the revenue.

2. The challenge begins over what is fixed and variable and what doctor consumes more of a given fixed expense.

a. One way to define “fixed” is to ask yourself: If my volume dropped 10 or even 20 percent, would I reduce a given expense? One might argue that the highest producer uses the most of the ‘front desk’ staff, but would the practice go from 3 to 2 or 2 to 1 if volume only moved 10 percent?

b. Another approach is to consider what changes with volume, collection fees, supplies, etc.

c. The simplest approach might be to pool all expenses other than those directly charged to the physicians. Once pooled, split the expenses into two pots using a predetermined ratio to be used throughout the year or beyond, say 50/50 – one for fixed expense to be divided equally and one for variable to be share based on production, either units or receipts. This greatly simplifies the monthly or quarterly calculation.

3. Keep books and records up to date with proper review of key components, particularly cash. One practice did not regularly balance cash reflected in the bank statement to the practice billing/collection reports. Over time, the practice’s cash was overstated and went unnoticed because it was a successful practice and tended to hold cash for capital acquisitions.

4. Timing – Many practices calculate compensation as quickly as possible so that money can be distributed.

a. In some of the cases above, the practice inadvertently masked the problem by delaying physician distributions until later in the next month. In another case, the problem went undetected because one or more physicians would take receipt of certain bonus payments only at year-end, or there were large one time payments, such as pension deposits made after year-end. This allowed errors in the formula to be funded by deferred bonus payments, pension deposits or other delayed payments.

b. Understand the time frame in which expenses and revenues are recorded and the duties of the individuals preparing the computation.

c. Consider regular monthly draws at 80 percent of the historical payment and issue a quarterly bonus on a scheduled basis. Note for professional corporations, the practice will need to accelerate the year-end calculation.

d. In practices where one or more physicians are dependent on the timely payment of money to meet financial obligations, the practice may want to have the physician work with a personal financial planner.

Conclusion

Physician compensation is the major driver in a practice’s long-term success. The key to group unity is having an understanding of the calculation and the checks and balances in place to ensure that the compensation is being calculated based on an agreed formula. When everyone understands the factors driving compensation and distributions everyone is more likely to work together as a group.

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